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Portfolio Choice with Illiquid Assets

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Author Info
Koren Miklós () (Harvard University Department of Economics)
Szeidl Ádám () (Harvard University Department of Economics, Littauer Center 200, Cambridge MA 02138-3001)

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Abstract

The present paper investigates the effects of incorporating illiquidity in a standard dynamic portfolio choice problem. Lack of liquidity means that an asset cannot be immediately traded at any point in time. We find the portfolio share of financial wealth invested in illiquid assets given the liquidity premium. Benchmark calibrations imply a portfolio share of 2 6% in cash. These numbers are in line with survey data and also with portfolio recommendations by practitioners. We also find that long horizon investors invest more in illiquid assets. Overall, our results suggest that differences between asset classes unrelated to standard price risk may influence portfolio shares.

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Publisher Info
Paper provided by Rajk László College in its series Rajk László Szakkollégium Working Papers with number 6.

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Length: 29 pages
Date of creation: Feb 2002
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Handle: RePEc:rlc:rlszwp:6

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  4. Abel, A.B., 1990. "Asset Prices Under Habit Formation And Catching Up With The Joneses," Weiss Center Working Papers 1-90, Wharton School - Weiss Center for International Financial Research.
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  5. Canner, Niko & Mankiw, N Gregory & Weil, David N, 1997. "An Asset Allocation Puzzle," American Economic Review, American Economic Association, vol. 87(1), pages 181-91, March. [Downloadable!] (restricted)
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  6. John Y. Campbell, 2002. "Consumption-Based Asset Pricing," Harvard Institute of Economic Research Working Papers 1974, Harvard - Institute of Economic Research. [Downloadable!]
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  7. Andrew W. Lo & Harry Mamaysky & Jiang Wang, 2001. "Asset Prices and Trading Volume Under Fixed Transactions Costs," NBER Working Papers 8311, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
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  9. Dumas, Bernard & Luciano, Elisa, 1991. " An Exact Solution to a Dynamic Portfolio Choice Problem under Transactions Costs," Journal of Finance, American Finance Association, vol. 46(2), pages 577-95, June. [Downloadable!] (restricted)
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  13. Vayanos, Dimitri, 1998. "Transaction Costs and Asset Prices: A Dynamic Equilibrium Model," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 11(1), pages 1-58.
  14. John Heaton & Deborah Lucas, 1993. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," NBER Working Papers 4249, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Lippman, Steven A & McCall, John J, 1986. "An Operational Measure of Liquidity," American Economic Review, American Economic Association, vol. 76(1), pages 43-55, March.
  16. Grossman, Sanford J & Laroque, Guy, 1990. "Asset Pricing and Optimal Portfolio Choice in the Presence of Illiquid Durable Consumption Goods," Econometrica, Econometric Society, vol. 58(1), pages 25-51, January. [Downloadable!] (restricted)
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  17. Carroll, Christopher D. & Samwick, Andrew A., 1997. "The nature of precautionary wealth," Journal of Monetary Economics, Elsevier, vol. 40(1), pages 41-71, September. [Downloadable!] (restricted)
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  18. Carol Bertaut & Martha Starr-McCluer, 2000. "Household portfolios in the United States," Finance and Economics Discussion Series 2000-26, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  19. George-Marios Angeletos et al., 2001. "The Hyberbolic Consumption Model: Calibration, Simulation, and Empirical Evaluation," Journal of Economic Perspectives, American Economic Association, vol. 15(3), pages 47-68, Summer. [Downloadable!] (restricted)
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  1. Geert Bekaert & Campbell R. Harvey & Christian Lundblad, 2005. "Liquidity and Expected Returns: Lessons From Emerging Markets," NBER Working Papers 11413, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Raj Chetty & Adam Szeidl, 2004. "Consumption Commitments: Neoclassical Foundations for Habit Formation," NBER Working Papers 10970, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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